The dangers with share buy-backs
Many businesses find operating through a company structure is attractive as the profits are taxed at a flat rate of 26% (if turnover is less than $50m), and a company can retain the after-tax profits to fund business expansion. When the business owners wish to withdraw some cash from the company, a share buyback is often an attractive option.
Share buybacks are complex transactions for tax purposes, and the following mistakes can inadvertently be made:
- Repurchasing and cancelling the shares at non-arms length values.
- Treating the share buyback proceeds as a 100% capital transaction.
The Australian Taxation Office (ATO) PS LA 2007/9 on share buybacks requires that share buyback proceeds be split between a dividend component and a capital component. The practice statement details the methods the ATO accepts in making the split between a dividend component and a capital component. Generally, if a company undertaking a share buyback has minimal paid up capital, and large retained profits, the share buy back proceeds will need to be allocated almost 100% as a dividend component.
The danger with making a share buyback that is not in compliance with ATO PS LA 2007/9 is the share buyback proceeds can be deemed an unfranked dividend. This is a disaster for the shareholder as instead of receiving a fully franked dividend from the company, they are receiving an unfranked one.
There is a lot of information on share buybacks on the internet that is incorrect for tax purposes. To avoid any adverse tax consequences a share buyback should only be undertaken after consulting a share buy-back tax specialist or receiving a private ruling from the ATO.